Underexplored Ways to Save for College

If you’re a parent and planning for the future, it’s never too early to start thinking about college. Putting a small amount away each month while your child is young can be the difference between schools, housing options and debt. While many parents rely strictly on a 529 savings plan, there are other underexplored and underutilized ways to save for those important years that come way too fast.

A 529 plan is a way to save for education expenses while taking advantage of unique tax benefits. You can use these plans to save for yourself, your child or another family member. They can be used for K-12 tuition, student loan repayments, apprenticeship programs and college. Withdrawals are tax-free and a plan may make you eligible for state tax deductions depending on where you live. These plans are flexible and you can change the beneficiary at any time. Earnings are tax-free and investment options include target date funds and ETFs.

There are also downsides to 529 plans. For example, if your child decides not to go the traditional route for college, there is a 10% penalty for money taken out that is spent on non-qualified education expenses. They do not have a federal tax deduction, and funds in a 529 plan can affect your child’s ability to get financial aid, which we’ll discuss in more depth below.

While 529 plans are one of the most common ways that parents save for college, there are other unexplored and underutilized options that may also be beneficial that we want you to know about. The options toward the end are a bit riskier and may have stricter requirements, every dollar matters as tuition costs rise across the country.

Coverdell Education Savings Account (ESA)

Education savings accounts are a valuable alternative to a 529 plan. You can withdraw money without tax penalties for educational expenses for college education or K-12 tuition. The downside to an ESA is that the contribution limits are set at $2,000 per beneficiary per year. Although there are some exemptions, ESA accounts may also have income limitations. 

An ESA account may be beneficial for families who are unable to contribute large amounts each year. ESA accounts can also be transferred to another family member if the money isn’t used by the original one.

Scholarship Opportunities

Experts estimate that almost $100 million of scholarship money goes unclaimed each year. This is simply due to a lack of applicants. Communities, K-12 schools and universities often have a long list of scholarships that students aren’t even aware of.

One way to combat this issue is to speak to a scholarship early in the 12th-grade year if your student’s school has one. If they don’t, work with the university your child plans to attend to find out what scholarships they are eligible for. Religious organizations, local businesses and other entities often offer scholarship money, and every little bit helps as tuition costs rise across the country.

Prepaid Tuition Plans

For those who want to avoid market volatility and don’t want to worry about the risks of tuition inflation, prepaid tuition plans are a valid option. These are attractive to risk-averse investors, but they can only be used to cover tuition, not room and board or other expenses. While it’s nice to prepay for tuition, there is also no opportunity for a return on the investment if it’s being spent rather than saved. There are no limits on how many credits you can purchase with a prepaid plan, and some states offer tax benefits.

Prepaid plans also require that your child have confidence in which university they plan to attend. Your student must also attend an in-state institution. Prepaid plans are ideal for those who are confident their child will attend an eligible university, who don’t want their education savings reliant on the stock market and who lack the desire to invest their education savings.

Unclaimed Pell Grants

Many students avoid the Free Application for Federal Student Aid (FAFSA) because they want to avoid student loans. What they don’t understand is that this form also qualifies the student for Pell Grants, which don’t have to be paid back.

There are some pros and cons to relying on federal aid. One major con is that the student’s aid is based on the parent’s income, but billions of dollars in grant money go unclaimed each year because students fail to apply.

Eligibility for grants is based on many factors, and the cutoff changes every year. Grants are awarded based on family size, student’s dependency status, state of legal residence and parent and/or student adjusted gross income.

If students don’t qualify for Pell Grants, they also have the option to obtain student loans through the Department of Education. While these do have the benefits of fixed interest rates and deferred payment until after school is complete, there are downsides. After graduation, the payment may not be affordable with salaries in certain industries. Parents and students should always put considerable thought into whether it’s a good idea to borrow money for school.

Savings Accounts

It sounds simple, but many people forget that a high-yield savings account is an effective way to save for a college education. These accounts have higher interest rates than traditional savings, so the investment grows faster. Most have flexible withdrawal and deposit policies, so you can access your money when needed. 

The downside to these accounts is that there are no tax credits related to education. Assets in these accounts can also work against your student when they apply for federal financial aid, and push them over the eligibility limit for Pell Grants.

Uniform Gifts or Transfers to Minors Accounts

Tax laws limit the amount of money a guardian can gift to a minor without tax liability, but accounts are available for those who have this option. The gifts or transfers can be made in the form of real estate, securities or money. Obviously, this is a more complicated way to pay for college, but works for those who have the advantage of a wealthy relative who can afford it. 

With these accounts, the guardian loses control of the assets once they’re transferred to the minor. This option also comes with fewer tax benefits, and having a large sum in an account can directly impact your child’s ability to qualify for financial aid. 

Education Tax Credits

The government encourages parents to send their kids to school through two specific tax benefits, and both can aid in the process of saving for future tuition payments or other college expenses. 

The first credit is the American Opportunity Tax Credit, which allows you to receive a credit of 100% of your first $2,000 spent on course materials, fees and tuition. For the next four years, you receive a credit for 25% of the amount. This credit has an income limit for single filers and married couples. It’s always a good idea to check it because it is often adjusted by the new tax code.

The second opportunity is the lifetime learning credit. This allows you to deduct 20% of up to $10,000 of education expenses. While it’s not a refundable credit (meaning you may not benefit from it if you get a refund), every penny counts. This credit is also reduced as your income gets higher, and both credits can’t be used at the same time.

In the end, efforts to save for college are highly individualized and customized to your situation. Whether it's through a savings plan, scholarships or tax credits, it's important to start researching education expenses early.

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